Global Financial Crisis Ppt

Pree Pr eent nted ed by by::

Outline of the Presentation y y y

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 What is Recession?  What is Financial Crisis? The Genesis of the current problem Impact on US Causes of Sub-Prime Crises Economic Imbalance Impact of the th e Crises  What did Goverments Goverments do? Effects on Developing Countries Role of G-20 G -20 in solving financial crises

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Effects on Pakistan Current scenario across the globe  Alternative View Conclusion

What is

Recession?

 A recession is defined as a period of time when the economy contracts (negative economic growth) for 2 consecutive quarters. A recession is characterized characterized by  y

Lower Output 

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Lower investment 

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Higher Unemployment 

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Increased PSNCR (Public Sector Net Cash Requirements) Lesser Economic Growth

What

is a Financial Crisis?

The term financial crisis is applied broadly to a variety of  situations in which some financial institutions or assets suddenly lose a large part of  their value. y

In the past financial cri crises ses have been generated generated by  combination of factors such as :

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Overshooting of markets markets

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Excessive Excessive leveraging leveraging of debt, and credit booms

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Miscalculations of risk Rapid outflows outf lows of capital from a country  country 

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Unsustainable macroeconomic policies

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Inexperience Inexperience with new financial f inancial instruments, inst ruments, and

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Deregulation without sufficient market monitoring and oversight.

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WHAT HAPPENED? Low interest rates, high leverage leverage and overconfidence led to the creation of bubbles which then burst««.

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It all started a decade back with a booming housing market in  America.

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The boom was later fueled by expansion expansion of liquidity in the system in the form of Mortgaged backed backed Securities and Collateralized Debt 

Obligations (CDO) invented by Wall Street. y

In the first few years there was just too much demand for all Investment Grade Grade properties.

Effective Federal Funds Funds Rate, Rate, June 1954 - Jan 2010 2010 nterest I nterest

Rates have gone from 2% to 20% and then down to 0.12%, They have nowhere to go but up now«..

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Fed Funds Rate Source:

Federal Reserve Board of Governors

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Sub-prime Mortgage Crisis y

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Mortgage brokers and Mortgage Lenders were more than happy to look for anybody and everybody who wanted a mortgage (Which in simple terms means home loan). In Initial few years boom was observed in American Housing Market because of Subprime Lending and CDOs. Between year 2002 and 2006 property price was increased by almost 40% . In case of Subprime Lending no one is taking enough care to see the repayment capacity capacit y of borrower b orrower,, in some cases even margin money   was waived off. This was a perfect foundation founda tion for fo r disaster. disaster. Equit Equityy was scarce and shortt in supply shor supp ly..

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The value of CDO started s tarted going downward. It was unable to pay  neither the capital nor the returns. During the year 2007, the balance sheet and profit account of  investment bankers, bankers, banks & financial institutions was favorable favorable and running the ride of optimism. This helped banks inf late their earnings and profit forecasts, and in turn their valuations. Bankers started leveraging their own banks in stock market. market. A close look at the leverage ratio of top 5 banks in US tells that it was an all time high during years 2003-2007. Higher the leverage ratio, higher is the default risk. If any bank is leveraged leveraged by 10 times, positive change change of $1 can bring $10 profit but negative change of $1 can bring $10 loss. With greed increasing day by  day, people were making irrational judgments.

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People were were buying buyin g as if there was no tomorrow tomorrow.. In year 2005, boom in economy was halted. In year 2006, there was marginal increase in property prices. In Year Year 2006, Fed has h as increased increase d its Interest rate which in turn affected lending rate of subprime loans.  As interest rate shoo shoott up, borrowers started defaulting, which whi ch resulted in increased supply and reduced prices. Contraction of liquidity means no aggressive lending, which in turn affected rollover of existing exi sting leverage . This caused downward spiraling spirali ng effect on stock price.

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The immediate cause or trigger of the crisis was the bursting of  the United United States Housing Housing Bubble Bubble which which peaked peaked in approximat approximately  ely  20052006.  Already-rising default rates  Already-rising rates on subprime and Adjustable rate rate mortgages (ARM) began to increase quickly thereafter. thereafter. However, once interest rates began to rise and housing prices started to drop moderately in 20062007 in many parts of the U.S., refinancing became more difficult.

 As housing prices declined, major global financial institutions institut ions that had borrowed and invested heavily in subprime MBS reported significant losses. Falling Falling prices also resulted in homes worth less than the mortgage loan.

Source: Bloomberg

US Housing

Bubble

IMPACT y

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ON US

Housing prices dropped 20% from their 2006 peak. Total home equity in the United States, which was valued at $13 trillion at its peak in 2006, had dropped to $8.8 trillion by  mid-2008 and was still falling in late 2008. The banks declared bankruptcy b ankruptcy which led to layoffs and thus the unemployment level reached its peak during 2008. Unemployment led to decrease decrease in i n demand, thus suffer losses  which again compelled compelled firms fi rms to decrease the number num ber of  employees and thus US U S entered into a vicious circle.

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By early early November 2008, the S&P 500 was down 45% 45% from f rom its 2007 high. Losses in retirement assets, savings, investment assets and pension assets suffered huge losses up to $8 trillion. By the the end of August 2008, 2008, various financial firms around the  world have written down their holdings of subprime subprime related securities by US$501 billion. By 2008 more and more financial firms either merged, or announced that they w were ere negotiating seeking seek ing merger partners.

Change

in US Real GDP, 1948-2009

This has been the worst downturn since end of World War II 

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Change

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owth Rate Gr ow

Source: Bloomberg

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Causes of Sub ub-P -Pri rime me Cri risi siss y

Boom y

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And Bust In The Housing Market:

The housing bubble that burst caused a negative wealth affect on the market as people began to panic and the situation rapidly  deteriorated on the face of falling market prices.

High-risk Mortgage Loans And Lending/ Borrowing Practices: y

Credit ratings were manipulated to reduce the risk levels of the mortgages by combing numerous securities in one large group known as MBSS (Mortgage Backed Securities). This had the affect of effectively hiding the risk factor of the loans and allowing  banks to sell them off to investors.

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Inaccurate Credit Ratings: Credit ratings were being assigned by credit rating firms that were in private hands, these firms were being paid by banks and in order to continue a good relationship with their clients. Low level risk  ratings were assigned to the special investment vehicles (SIV·s) the banks were using. At one point Moody had 40% of its income coming from the inflow of such credit rating activities. y

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Government Policies: Extremely low interest rates, de-regulation and giving credit rating  authority to the private sector. y

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Boom y

And Collapse of the Shadow Banking System: The shadow banking systems were the mutual funds and their like that played an important role in providing funds to corporations and other enterprises, however, they lacked the regulation and oversight of the banking industry.

Economic Imbalance y

Commodity Boom: The decade of the 2000s saw a global explosion in prices, focused especially in commodities and housing, marking an an end to the commodities recession recession of 1980-2000. y

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In 2008, the t he prices of many commodities, notably oil and food, rose so high as to cause genuine economic economic damage, damage, threatening stagf lation and a reversal of globalization. In January 2008, oil prices surpassed $100 a barrel for the first time, the first first of many price pri ce milestones to be passed in the course of the year. year. In July 2008, oil peaked at $147.30 a barrel.  An increase increase in oil prices pri ces tends to divert a larger share of consumer cons umer spending spending into gasoline, gasoli ne, which creates downward downward pressure on economic growth in oil importing countries, as wealth flows f lows to oil-producing states.

Source: Bloomberg

Source: New York Times

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Trade:  In mid-October 2008, the Baltic Dry Index, a measure of  shipping shippi ng volume, volume, fell by 50 per cent in one week, as the credit crunch made it difficult diff icult for exporters to obtain letters of credit. credit. Unemployment: The International International Labour Organization Organization predicts predicts that at least 20 million jobs are likey likey to be lost by the end of 2009 due to the crisis mostly in "construction, real estate, financial services, and the auto sector"  bringing world world unemployment above 200 million mill ion for the first firs t time. y

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Inflation: y

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In February February 2008, Reuters reported that global inflation was at historic levels, and that domestic inflation was at 10-20 year highs for many  nations. Excess money supply around the globe, monetary easing by the Fed to cultivated financial crisis, growth surge supported by easy monetary  policy in Asia, speculation in commodities, agricultural failure, rising  cost of imports from China and rising demand of food and commodities in the fast growing emerging markets. Inflation was also growing in countries classified by the IMF as "non-oilexporting LDCs" (Least developed countries) and "Developing Asia", on account of the rise in oil and food prices.

The price of gold rose by 30% from middle of 2007 to end of 2008.

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ar:  W ar: y

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The recent wars in Afghanistan and Iraq have had a significant  role to play in the causes of the current economic recession.  A current estimate of the total cost of the war is $1.6 trillion by  the end of 2009 Massive U.S government borrowing that contributed heavily to the debt burden of the government and a nd reduced money supply   At the same time it also added an atmosphere of uncertainty to the Middle East causing fears of disruption to the oil supply and increasing price levels.

Impact y

of the Crisis

Collapse of Financial Institutions in several parts of the  world Lehman Brothers; AIG, Freddie Freddie Mac and Fannie Fannie Mae etc. y

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Central Banks in vulnerable countries such as Iceland become Bankrupt Investors across the globe lost huge amount of their investments Severe Credit squeeze and Liquidity crunch for the industry  Housing; Automobiles; Automobiles; Retail; Services Ser vices etc. etc. y

Scale of the potential bailout  (already up to $850bn)

Net foreign investment in the United United State Statess (1993 ² 2009) 2009)

Financial Crisis On Stock Market Stocks low est since y

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9/11

The Dow industrials dropped 504.48 points to close at 10,917.51, the first time since July its finished under 11,000. It was the sixth-largest point drop ever and the worst since Sept. 17, 2001, when the average f ell f irst day of  ell 684.81 points on the first trading after the terror attacks. Broader stock indicators also fell. The Standard & Poors 500 index lost more than 4 1/2 percent, and the the Nasdaq Nasdaq composite composite index index lost more than 3 1/2 percent.

The End Of The Stock Market Market Boom....

Source: Economist Dec, 2008

What ntervened I ntervened

Did Governments Do?

in order to prevent a systemic collapse and an economic depression«««.

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Governments responded swiftly and decisively to save the system

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Central banks stepped in and provided liquidity to the banking system allowing it to keep functioning

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Expanded the money supply

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Governments provided bailouts for major financial institutions to avert their collapse or took them over outright

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Governments also cut taxes and raised spending to prevent the economy from falling into a deep recession or even depression depression

Effects on Developing Countries y

Trade And Trade Prices: y

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Growth in China and India has increased imports and pushed up the demand for copper, oil and other natural resources, which has led to greater exports and higher prices, including from  African countries. Eventually, growth in China and a nd India is likely  to slow down, which will have knock on effects on other poorer countries.

Remittances: y

Remittances to developing countries will decline. There will be fewer economic migrants coming to developed countries when they are in a recession, so fewer remittances and also probably  lower volumes of remittances per migrant.

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Foreign Direct Investment (FDI) And Equity Investment: These will come under pressure.  W hile hile 2007 was a record year for FDI to developing countries, equity finance is under pressure and corporate and project finance is already weakening. The proposed Xstrata takeover of a South African mining  conglomerate was put on hold as the financing was harder due to the credit crunch. y

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Commercial Lending: Banks under pressure in developed countries may not n ot be able to lend as much as they have done in the past. Investors are increasingly, factoring in the risk of some emerging market  countries defaulting on their debt, following the financial collapse of Iceland. This would limit investment in such countries as  Argentina, Iceland, Pakistan and Ukraine. y

 Aid:

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 Aid budgets are under pressure because of debt problems and weak  fiscal positions, e.g. in the UK and other European countries and in the USA.  W hile hile the promises of increased aid at the Gleneagles summit in 2005 were already off track just three years later, aid budgets are now  likely to be under increased pressure.

 Whil e the effects will  While wil l vary from country to country, country, the economic impacts could include:

 Weaker export revenues Further pressures on current accounts accounts and balance of payment Lower investment and growth rates Lost employment There could could also also be social effects Lower growth translating into higher poverty 

Worl Wo rl

onomii onom

er cent cent (%)

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r ojecti ojections ons f or

r owth owth

8 7 6 5 4 3

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4

Advanced Economi Economies

ce: Sour ce:

IMF WEO Upda Updatte, Jan Janu uary 6,

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Emergin rging Economi Economies

8 World rld Aver age

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Declaration of the Summit taken place in November November 2008: 1) To enhance cooperation among the nations and work together

to restore restore global growth and achieve needed reforms in the  world's financial systems. 2) Lay the foundation for reform to help to ensure that a global

crisis, such as this one, does not happen again. 3) To ensure that market principles, open trade and investment investment

regimes, and effectively regulated financial markets foster the dynamism, innovation, and entrepreneurship that are essential essenti al for economic growth, growth, employment, and poverty  reduction.

Impact y

Capital y

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on Pakistan

Flows and W orkers Remittances:  A stressed international economic environment has held back Foreign Investment as it posted a decline of 47.5 per cent during the first ten months of 2008-09

 Workers remittances to Pakistan remained vigorous and unaffected by the crisis, crisis, totaling US$ 6.36 billion in July-April July-April

Commodity y

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Prices and Trade:  An unprecedented hike in international commodity prices wreaked wreaked chaos on Pakistans Pakistans external sector during 2007-08, with the current account widening significantly.

However, in the wake of a reduction in global demand and the resultant decrease decrease in commodity prices, prices, the import bill has reduced significantly, decreasing the current account deficit

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External

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Financing:

The global crisis has restricted restri cted Pakistans ability to tap the international debt capital markets to raise funds. Pakistans presence in the international capital markets in 2008-09 was limited.

Fiscal

Year 2008-09

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Economic activity significantly slowed down in 2008-09.

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The current account account deficit def icit narrowed n arrowed to 5.1 per cent of GDP. GDP.

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Overseas remittances remittances have have increased but financial inflows inf lows (such as FDI and portfolio investment) dropped sharplyby over over 37 per centdue to macroeconomic instability and global recession. SBP foreign exchange reserves rebounded to about $9.1 billion (2.9 months of imports) by end-june end-june 2009 Fiscal problems continued continued during 2008-09 and the fiscal f iscal deficit target was 5.2 per cent of GDP. GDP. Overall Overall revenues fell substantially short shor t of the target primarily due to a drop in tax ta x revenues as the economic economic slowdown reduced Pakista P akistan's n's two main tax bases-manufacturing and imports

Current Scenario Across the Globe: y

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The world is trying to recover from the aftermaths of one of the Greatest Recessions so far with the developing countries like India and China leading the way. The World World Bank projects global GDP to expand between 2.9 and 3.3 percent in 2010 and 2011, strengthening to between 3.2 and 3.5 percent in 2012, reversing the 2.1 percent decline in 2009. Developing economies are expected to grow between 5.7 and 6.2 percent each year from 2010-2012. High-income High-i ncome countr countries, ies, however, however, are projected to grow by between bet ween 2.1 and 2.3 percent in 2010not enough to undo the 3.3 percent contraction in 2009followed by between 1.9 and 2.4 percent growth in 2011.

Alternative

View

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Taken strong actions to stimulate the economies, provide liquidity, liquidity, strengthen the capital of financial institutions, protect savings savings and deposits, unfreeze credit markets, and to ensure that International Financial Institutions (IFIs) can provide critical support for the global economy.

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Recognize the importance of monetary policy support, as deemed appropriate to domestic conditions.

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Ensure that the IMF, IMF, World World Bank Ban k have sufficient resources reso urces to continue contin ue playing their role in overcoming the crisis.

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Reviewing and aligning global accounting standards, particularly for complex securities in times of stress.

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Governments

and Central Banks around the world must be active in supervising and monitoring the activities of financial firms locally and internationally. internationally.

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International Monetary Fund (IMF) should play a major role in regulating and auditing the global financial system.

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Investment companies should be punished for conducting unfair practices in some countries (Tax Evasion) and financial practices must be consistent globally. globally.

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Restrict the leverage leverage that financial institutions institutions can assume.

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Establish an early-wa early-warning rning system to help detect systemic risk.

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Require Require stronger capital and liquidity positions for financial firms and related regulatory authority.

Conclusion y

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The recession of 2007-09 was considered to be severe, all this showed us was the need for strong government regulation and oversight of  the market in comparison compar ison to a completely free market scenario. Bailout packages packages will benefit the firms f irms only in the short run. A firm  will need to assess its financial position and need to take corrective corrective action to prevent such circumstances in the future. The question of Global Economic Recovery taking place is highly  debatable debatab le however, however, we can conclud concludee that the recovery is indeed taking place. The road to recovery is not smooth and will take a long time before things get get stabilised and everything is back to normal.